Pandemic Is a Great Incubator for Financial Fraud

by Joe Nocera: The Berkeley Center for Law and Business held its annual “fraud fest” a few weeks ago — virtually, of course — and there was a new item on the agenda. Along with the usual panels about whistle-blowers and short sellers, the organizers added a panel titled “Fraud and Covid-19.”

“The pandemic is the perfect storm for fraud,” one of the panelists said, and who can doubt it? The federal government hastily pushed hundreds of billions of dollars out the door in the largest bailout in U.S. history with only the most vague requirements for recipients; bankers working from home doled out those billions to small businesses; regulators loosened rules to help institutions get through the crisis. As my colleagues Timothy L. O’Brien and Nir Kaissar noted recently, “the White House has made it easier for government insiders to obtain bailout loans from the Small Business Administration, creating a raft of conflicts of interest.”

That certainly sounds like a recipe for financial fraud.

“A crisis is like the fog of war,” said Thomas Curry, the former comptroller of the currency during President Barack Obama’s administration. “Banks redirect resources to critical areas and neglect other risks that bite you down the road.”

Before becoming comptroller, Curry was on the board of the Federal Deposit Insurance Corporation. It was from that perch that he watched the financial crisis unfold — and became one of the financial regulators frantically trying to keep the U.S. financial system from melting down. The government ultimately gave the big banks billions in bailout loans and other forms of support, such as buying their toxic securities.

But once the crisis was averted, Congress, regulators, and the press all began to dig into scandals that were previously unnoticed: the abuse of subprime mortgages by the big financial players; the craven behavior of the credit-rating companies; the willingness to mislead investors who bought those toxic securities, and so on. According to the boutique investment bank Keefe, Bruyette & Woods, banks were fined a staggering $243 billion for their misdeeds during the financial crisis. (Bank of America leads the pack with $76.1 billion in fines.)

Those fines inflicted some pain, but they weren’t the most consequential result of the financial misdeeds that were exposed. The larger issue was the enormous resentment and anger they generated in a broad swath of the country. People on both sides of the political divide were furious that the big banks were being saved despite bad behavior that helped create the financial crisis. Meanwhile, millions of bank customers lost their homes to foreclosure. The financial crisis and its aftermath helped bring about the Tea Party and Occupy Wall Street movements and helped pave the way for Donald Trump’s presidency.

So here we are again, in the middle of another crisis, only this one is being overseen by an administration that doesn’t seem to care much about corruption or fraud. Early on, Trump removed Glenn Fine, the acting Pentagon inspector general, from taking charge of a group that was supposed to monitor the pandemic relief effort, replacing him with someone more to his liking. Nobody is monitoring the White House’s involvement in procuring N-95 masks and other scarce personal protective equipment.

And only on Monday did the Treasury Department finally release the names of companies that received PPP funds. Guess what? One recipient was the law firm of Kasowitz Benson Torres, where one of the name partners, Marc Kasowitz, has represented Trump for years. The firm received between $5 million and $10 million, according to the New York Times.

As for the banks, the SBA has put them in a terrible spot, giving them the responsibility of hastily vetting the hundreds of thousands of businesses seeking PPP funds. Even with the best of intentions, it is inevitable that scam artists found ways to bilk the banks out of PPP loans. Indeed, prosecutors have already arrested a handful of executives for doing so.

The larger issue is that, just like in 2008, regulators aren’t focused on preventing misconduct. Instead, their focus is on making sure banks have the ability to lend — even if it means loosening rules that were designed to make banks safer. In late March, for instance, the Federal Reserve relaxed several lending rules, including one that measured counterparty credit risk. And in early April it loosened capital requirements.

“The Fed has been trying to say to the banking community that in this crisis environment we don’t want the constraints we normally put on you. We don’t want to hamper your ability to lend to clients,” said Gary Cohn, the former Goldman Sachs executive who served as Trump’s first chief economic adviser.

What’s more, Cohn said, banking is not a business that is meant to be conducted from home. “Banks need people to be working together in a cooperative fashion and watching and listening to each other,” he told me. “That is what the Fed would call a first line of defense: Overhearing conversations, looking at presentations, or looking at the way you talk to a client. Or calling a compliance officer – ‘Can you guys look at this?’ When people are sitting in their bedrooms,” he added, “there is no one there to look over their shoulder.” Bankers operating on their own is a recipe for trouble.

When the pandemic finally ends, there are going to congressional investigations, newspaper exposes and special commissions all taking a look back at what happened to the trillions of dollars the federal government spent to keep the economy from collapsing. Indeed, if the Democrats sweep the White House and Congress, the reckoning could well begin even before the virus has been conquered. (Can you just imagine Elizabeth Warren as chair of the Senate Banking Committee?)

For starters, they’ll want to know whether bankers siphoned off money to their friends, whether they threw people who should have been granted mortgage forbearance out of their homes and whether money meant for small businesses wound up helping any of the president’s businesses.

Banks will be especially vulnerable because they were the villains during the last crisis. If significant bank misconduct is uncovered during a Covid-19 post-mortem, said Stephen Scott, the founder of Starling Trust Sciences, a risk-management company, “there will be pitchforks.”

The country is much more polarized than it was in 2008, and much angrier, too. If it turns out that the billions of dollars intended to help out-of-work Americans was diverted by fraud, it will make the aftermath of the financial crisis look like a picnic.
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Joe Nocera writes for Financial Accounting News at Bloomberg Tax.  Article shared by Truth in Accounting.

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